Collateral, Rationing, and Government Intervention in Credit Markets
33 Pages Posted: 30 Dec 2006 Last revised: 11 Jun 2008
Date Written: July 1989
This paper analyzes the effects of government intervention in credit markets when lenders use collateral, interest, and the probability of granting a loan as potential screening devices. Equilibria with and without rationing are examined. The principal theme is that credit policies operate through their effect on the incentive compatibility constraint, which inhibits high-risk borrowers from mimicking the behavior of low-risk borrowers. Any policy that loosens (tightens) the constraint raises (reduces) efficiency. Most government credit programs explicitly attempt to fund investors that cannot obtain private financing. In the model presented here, these subsidies increase the extent of rationing and reduce efficiency. In contrast, policies that subsidize the nonrationed borrowers, or all borrowers, are efficiency enhancing, and reduce the extent of rationing.
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